Dividend Discount Model – Share Price Risk – Technical Analysis

Dividend Discount Model (DDM)
(a) Company A pays an annual dividend of 35p per share. The required rate of return is 11% p.a.

(i) If that level of dividend payment is expected to be constant into the future what is the intrinsic value (or fair price) of the share?
(ii) If the next dividend payment is expected to be 7% higher than the last, and if this rate of dividend growth is expected to be maintained over time, what is the intrinsic value of the share?

(b) Company B is a new company that is currently enjoying rapid growth. It is estimated that dividends will grow at an annual rate of 12% over the next four years. After that, the growth rate will fall to 6% p.a. and remain at that rate. The directors have just paid an annual dividend of £1.25.
Calculate the intrinsic value of the share if the required rate of return 15% p.a.

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(c) Company C has seen dividends per share grow at 5.8% p.a. recently but expects the growth rate to decline linearly over the next 6 years (period 2H) to 4% p.a. The beta of the stock is 0.9, the risk-free rate is 4.4% p.a. and the market risk premium is 3.7% p.a. The last reported dividend was £0.51. Calculate the intrinsic value of the share.
(d ) Identify the assumptions that are made about how dividends change over time in the following dividend discount models: the constant rate of dividend growth model, the 2-stage model, the H-model and the 3-stage model. Discuss which model is most realistic.

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Share Price Risk

(a) Fama and French tested the extent to which excess return (return on asset i minus risk free return) was a function of: market risk (market return minus risk free), size risk (small minus big -SMB) and value risk (high minus low -HML). Discuss what their findings suggested about the importance of market risk in explaining the returns made to shares.

Share Price Risk

Share Price Risk

 

Estimate the values of the following types of risk in relation to shares A and B: total risk, relative risk, systematic risk and non-systematic.
(b) Calculate the required rate of return for each share assuming that the risk-free rate of return is 4% p.a.

 

Technical Analysis


(a) Explain how technical analysts use moving averages to identify buy and sell signals in financial markets. Explain why moving averages identify changes in the momentum of price movements.

(b) Describe the nature of the technical relationships found in the Thomson Reuters/Jefferies CRB commodities index and the CNET Networks share price in the charts shown below. Explain the reasons why such technical patterns may develop.

(c ) According to the efficient markets hypothesis, if financial markets are weak form efficient then technical analysis should not be able to identify any profitable trading signals. Discuss whether or not weak form efficiency holds in financial markets.

 

Dividend Discount Model – Share Price Risk – Technical Analysis